DOL Proposal on ESOP Fair Value: Withdrawn but Not Forgotten

by Prof. Robert Bloink and Prof. William H. Byrnes

Prior to Trump’s January executive order freezing all regulatory action, the Department of Labor (DOL) issued long-awaited proposed guidance for employee stock ownership plans (ESOPs) seeking to rely on an ERISA prohibited transaction exemption.  While the Biden-era guidance now technically remains frozen and has no legal effect, it does offer ESOPs some insight into what constitutes adequate consideration and fair value in the context of ESOP transactions that involve private company stock.  The proposed rulemaking is the first set of formal guidance in nearly 40 years on how the DOL views a proper determination of fair market value of private corporation stock in ESOP transactions.  As such, interested parties should understand the parameters of the guidance even as the new administration takes shape.

ESOP Fair Value Issue: Background

By way of background, ESOPs are generally protected under the ERISA prohibited transaction rules when they purchase private company stock only if the ESOP pays no more than adequate consideration for the stock.  “Adequate consideration” is defined under ERISA as the fair market value of the asset, as determined by the trustee or fiduciary under the terms of the plan in good faith, in accordance with regulations promulgated by the DOL.

The DOL, however, has never finalized regulations on point.  The closest they came was a set of proposed regulations released in 1988.

The SECURE Act 2.0’s Worker Ownership, Readiness, Knowledge Act (WORK Act) provision provided that the DOL develop standards and procedures to establish good faith fair market valuation standards for ESOPs who acquire shares of a business.

In January of 2025, the DOL withdrew the 1988 proposed regulation and replaced it with a proposal that contained a two-part test that would have applied to both purchases and sales of private company stock by ESOPs.  Under the proposals, ESOP fiduciaries would be required to both determine the fair market value of the stock and use a good faith process (based on ERISA fiduciary standards) in arriving at the fair market value.

DOL’s Proposed Test for FMV Determinations

The price of private company stock acquired by an ESOP must reflect the fair market value of that stock.  Pursuant to the DOL proposal, that fair market value must be based on objective factors, rather than any circumstances unique to any particular investor.  The price that the stock would carry in the market at large, in other words, must be considered rather than any characteristics unique to the investor.

The ESOP must consider the purchase as though it were being made on a cash basis (or cash equivalent), disregarding the terms of any debt financing actually being used to purchase the private company stock.  The fair market value must be determined as of the date of the transaction, considering all information that is known , or reasonably obtainable, about the stock as of the date of the transaction.

In making their determination, the ESOP fiduciary must use a good faith process (part two of the January proposal).  As a part of the good faith process, the fiduciary must select a qualified independent valuation appraiser and oversee a valuation report (in writing) that reflects current and accurate information about the transaction and the ESOP sponsor.  In reviewing the valuation report, the fiduciary must exercise fiduciary judgement to ensure that the report is suitable to rely on as a basis for determining the fair market value of the stock in light of relevant facts and circumstances.  At all stages in the valuation process, a prudent person standard applies.

Assuming that the ESOP follows this two-part test, the prohibited transaction rules would protect the ESOP if the ESOP made a good faith effort to determine fair market valuation, yet the seller of the private company stock provided misleading or incomplete information.

The DOL heavily emphasized the potential for abuse in ESOP transactions, highlighting many ERISA violations in the DOL’s analysis of ESOP transactions over a 20-year period, including situations where an ESOP paid for a controlling interest in a business yet did not receive such a controlling interest, hired biased appraisers, relied on non-comparable companies as valuation benchmarks or disregarded pre-existing debt when determining valuation.

Conclusion

Again, the proposal currently does not carry the weight of law.  It does, however, provide valuable insight for ESOP sponsors who are engaged in the process of purchasing or selling private company stock going forward.  Due to the proposal’s heavy reliance on existing ERISA fiduciary standards, responsible plan fiduciaries may wish to consider the now-withdrawn guidance for determining best practices whenever engaging in purchases or sales of private company stock.

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